| Deeply divided on the direction of long-term rates, some debt fund managers suggest that it may be the best time to buy income funds while others advocate taking shelter in the safety of liquid funds.
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| December 2005 was not quite an exciting month for banks and the bonds market. Thanks to the India Millennium Deposit (IMD), around Rs 33,000 crore flushed out of the banking system.
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| Money had been in short supply for the next three months. And, due to tight liquidity short-term interest rates spiralled to as high as 9 per cent by March 2006, prompting the central bank to pump in around $8 billion.
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| With the fresh lease of life provided by the apex bank and the increased government spending, interest rates stabilised somewhat. The tightening of liquidity helped short-term debt funds and liquid funds as they could earn higher rates by lending to cash-starved banks.
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| But income funds, which invest usually in slightly longer term papers, continued to suffer as rising yields dragged down bond prices. Now that the markets are probably becoming more predictable, where should you invest for safe and stable returns? The answer isn't easy, as experts are divided on their opinions.
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| Says Sandeep Bagla, head of fixed income, Principal PNB Mutual Fund, "Due to the substantial rise in liquidity over the past couple of months, short-term rates have come down. But the long-term rates have not changed much. So, there is a clear opportunity now to invest in long-term instruments."
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| After the RBI pumped in liquidity into the system in March, call rates have gone down from around 7.5 per cent to 5-5.5 per cent at present. Also three-month CP (commercial paper) and CD (certificate of deposit) rates are down to 6.5 per cent now, from 8.5 per cent till March.
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| However, long-term rates, which do not get impacted much by liquidity but by factors like global interest rates, RBI policy, inflation and oil prices, have remained where they were. Yield on 10-year government paper, which was hovering around 7.4 per cent in March, is now only marginally higher at around 7.5 per cent.
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At this point of time, Bagla suggests investing at least a part of the investible surplus in gilt funds and income funds. It is a good time to make most of the prevailing high yields. There is distinct possibility of generating capital gains over the next three-six months as 10-year yields are ruling at a four-year high.
| TOP FIVE | | (NAV as on May 9, 2006) | | Gilt funds-long term | 1 Year Return(%) | | UTI Gilt Advantage Fund - LTP | 6.17 | | Birla GPRP | 5.74 | | Principal G Sec - Investment | 5.74 | | Reliance G Sec Fund -LTP- Retail | 5.49 | | BirlaGPPFP | 5.44 | | (NAV as on May 9, 2006) | | Monthly Income funds | 1 Year Return(%) | | HDFC MIP - LTP | 22.11 | | Reliance MIP | 20.47 | | Birla MIP II - Wealth 25 | 18.15 | | Kotak Income Plus | 17.32 | | HSBC MIP - Savings Plan | 17.06 | | (NAV as on May 9, 2006) | | Income funds-retail plans | 1 Year Return(%) | | Tata Income Plus Fund-RIP-(Option A) | 6.13 | | Prudential ICICI LTP - Cumulative | 5.74 | | LIC Bond Fund | 5.41 | | Principal Income Fund | 5.27 | | DWS Premier Bond Fund-Regular Plan | 5.19 | | (NAV as on May 9, 2006) | | Liquid funds-retail plans | 1 Year Return(%) | | LIC MF Liquid Fund | 6.16 | | Canliquid Fund | 6.00 | | DSP ML Liquidity Fund - Regular plan | 5.89 | | DBS Chola Liquid Fund - Regular | 5.84 | | UTI Money Market | 5.77 |
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| "It is a better time to invest than any time in the last four years," says Bagla. He feels that liquidity is likely to be easy in the coming months, as there is no reason for any tightness.
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| "Also, a lot of demand from banks to maintain their SLR (statutory liquidity ratio) will prevent yields from going up in the next three-six months," he reasons. Could rising inflation driven by higher commodity prices play the spoilsport? Bagla is confident it won't.
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| "The monetary policy has limited role to play in controlling supply side inflation, so the central bank could pause for some time in increasing rates, as any further rise could impact growth rates in the market," he says.
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| On the other hand, Mahendra Jajoo, head of fixed income, ABN Amro Mutual Fund, has a starkly contrasting view. He feels that long-term bond yields are expected to increase.
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| "In the second half of 2006, Fed may increase rates by 25 basis points. Also continued economic expansion implies strong credit pick-up and further appreciation in asset prices. So, inflation is likely to increase owing to rising commodity prices. Thus, long-term bond yields are likely to go up," says Jajoo.
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| But, as Bagla sees it, the current bond prices seem to have discounted one or two rate hikes of 25 basis points. Hence, any further increase will not affect the yields much.
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| Nilesh Shah, chief investment officer, Prudential ICICI Mutual Fund, shares the same view as Jajoo's.
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| Shah says, "Increasing asset prices, real estate prices, commodity prices and oil prices all point towards rising inflation. Also, global rates are expected to go up. So, interest rates will increase gradually," adding that "in such a scenario, it is better to invest in short-term instruments".
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| Jajoo recommends investors to remain invested in liquid funds, FMPs (fixed maturity plans), MIPs (monthly income plans) and balanced funds.
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| He says income funds must be avoided as prices of bonds may be under pressure due to rising yields. "By the end of 2006, I expect a hike of 50 basis points in the reverse repo rate," says Jajoo.
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| "Liquid funds are safe haven kind of investments and the average maturity of liquid fund portfolios is around 100 days. So, its yields get re-priced according to the market senario," says Jajoo. Liquid funds have delivered returns of about 5.54 per cent in the last one year.
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| "Through MIPs investors can take the benefit of healthy equity markets, thereby earning better returns at lower risk, as the equity component is lower," he says.
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| MIPs are medium-term debt-oriented funds with a mandate to invest a portion "� usually around 20 per cent of their assets "� in equities. MIPs have delivered returns of about 14.55 per cent in the last one year.
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Similarly, balanced funds invest predominantly in high-quality debt income instruments with almost equal weight to equities. This gives investors an opportunity to earn higher returns.
| AVERAGE CATEGORY RETURNS | | (NAV as on May 9, 2006) | | Returns in (%) | 1 Month | 6 Months | 1 Year | | Income Funds-Retail Plans | 6.59 | 2.54 | 4.10 | | Liquid Funds - Retail Plans | 6.02 | 5.73 | 5.54 | | Monthly Income Funds | 18.55 | 16.32 | 14.55 | | Gilt Funds - Long Term | 5.30 | 3.16 | 4.64 |
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| FMPs invest in instruments that mature at the same time when their schemes come to an end. Jajoo says, "In case of FMPs, the investor's money is protected from capital loss, as the maturity is linked with the investment horizon."
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| Also, investors get tax benefits "� the dividend is tax-free in the hands of individual investor. FMPs with a one-year time horizon are eligible for indexation benefits, which substantially reduce the tax burden. Capital gains are taxed at 20 per cent after accounting for indexation or 10 per cent without indexation benefit.
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| As experts still remain divided on where to invest when it comes to steady returns, we would suggest "when in doubt, play it safe". |
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